Notes From Underground: Laugh, Laugh, I Thought I’d Die

Two big issues have been the rage of financial news during the weekend. First, the Chinese Central Bank lowered its reserve requirements by 50 BASIS POINTS in what is being termed an effort to engineer a “soft landing” and prevent a drastic fall in GDP. This is my first laugh as the raises in the reserves during the last 18 months did little to slow the economy. Besides, if the Chinese Politburo wants to install pro growth policies it has control of the credit creating mechanism. As the markets are looking for anything that sustains the recent global equity rally, why not the Chinese reserve ratio?

More important news out of China is word that the Japanese and Chinese are uniting on a package to aid the IMF‘s need for more funding. The U.S. is usually Japan’s comrade on IMF decisions but it seems that the two largest non-domestic holders of U.S. Treasuries are cooperating to be able to help the Europeans through the IMF.

This is certainly a sign that the U.S. control over the IMF is waning and the politics of international institutional finance are in the midst of a major change. Say goodbye to the atavistic remains of 19th century colonialism. The Japanese will be able to find all sorts of investments with the newly created liquidity.

The second LAUGH, of course, emanates from Europe and it has two parts. The main holdout to the Greeks getting their funding was the idea of whether or not Greece was going to be able to get its 2020 debt level down to 120% of GDP. The IMF has calculated that based on all the Greek’s austerity efforts, the DEBT/GDP level would only be 129% versus the obligatory 120%. In an Ambrose Evans-Pritchard piece, “Germany Bows to Global Pressure and Signals Greek Rescue Deal,” Pritchard cites German Finance Minister Schaeuble that there is wiggle room to be at 123% rather than the IMF‘s hard 120% DEBT/GDP ratio.

This is so ridiculous that the Greek deal is hanging in balance on a 2020 forecast. These wunderkinds haven’t come close to projecting any of the budgets for the last two years and now they are concerned about 2020. AND YET THE MARKETS REACT TO THIS NONSENSE! To further confirm the failure of European projections, Peter Spiegel has an article in tomorrow’s Financial Times, “Greece Indignation Threatens to Spread,” as the concept of FISCAL UNION is being seen as anti-democratic.

The EU‘s top economic official, OLLIE REHN, has met pushback from some of the peripheries for the way his fiscal policy actions are undermining the domestic democratic institutions. Mr. Rehn threatens severe penalties for those nations that cannot meet the budget deficit numbers to which various nations have agreed so that they could attain funding through any member of the TROIKA(IMF, ECB, EU). The nations in question are beginning to fear that Brussels will demand that TECHNOCRATS seize the reins of government so as to put the necessary policies in place. (Italy and Greece are the recent examples.)

Peter Spiegel goes on to report: “This week, Mr. Rehn is due to present economic projection confirming that Spain is WILDLY OFF ITS AGREED DEFICIT-REDUCTION TRACK. (EMPHASIS MINE) The new centre-right government has already said the Spanish public deficit soared to 8% of national output in 2011-far worse than its predecessor had predicted. This year Spain is supposed to get to 4.4%. That is not going to happen.”

The impact of ADVERSE FEEDBACK LOOPS resulting from severe austerity budgets is nothing to LAUGH AT, BUT WORRYING ABOUT 2020’s deficit projections is so ludicrous that laughter becomes the best medicine. The market likes the end result that Greece is getting its money so now it will be on to Portugal to test Herr Schauble and his promise that Germany will stand by Portugal and meet its needs. This week will be a test of the resolve of many Europeans and so the 2/10 yield curves will be significant indicators of the markets genuine outlook.

With private sector deleveraging and the EU policymakers stuck on pushing fiscal austerity, we have a “real world” living experiment as to the validity of Richard Koo’s “Balance Sheet Recession” theory. Early signs (the dramatic widening of deficits as the fiscal policies are implemented in Greece, Portugal and Spain (also UK)) support Koo. the eurocrats’ policies are exactly those that Koo believes will exacerbate the problems. It is also very relevant in Germany with the balanced budget commitmentments looming. Expect a deep and extended Euroland recession (laughable sell side forcasts minus 0.5% in 2012 then 1.1% growth in 2013).

Not important for the US? With the extended unemployment benefits and payroll tax cuts being confirmed for the rest of 2012, the total fiscal drag for 2013, given current law, is now about 4% of GDP (expiry of Bush tax cuts and start of super-commitee automated spending cuts). Yet forecast growth in the US is 3.5% for 2013??? Are the analysts saying there will be bi-partisan agreement to defer the deficit problem yet again, or is the number just plain wrong?

Arthur–again you link to a good article.While I may not always agree with Hendry’s trade analysis I have great respect for his thought process and his being able to see the global macro picture.He is one of the favorites of the DROBNY Group and for good reason.Trying to understand the world in all its political,economic machinations is a continuous challenge and people like Hendry help to sort thru and understand the possibilities–not the probabilities.As a life long CUBFAN I JUST WISH HIS NAME WASN’T HENDRY—MAYBE WE COULD REFER TO HIM FOR NOW ON AS THEO.

KEVIN—your students ought to be celebrating that you bring the world of finance into real time amd are preparing them to understand how not to repeat the debacles of the last twenty years.It is time to revisit the work of Richard Koo and get people to read the HOLY GRAIL OF GLOBAL MACRO ECONOMICS.Now the question is –WHAT WOULD IRVING FISCHER HAVE PRESCRIBED and what would his views on Schauble’s present stance be??

As a previous student of Kevin’s, I’ve been imparted a healthy skepticism of markets and policymakers. Now, in NFU 101 with Prof Harris, I see those put to use on the macro stage. Quite the education and sans the gen eds to boot.

I think the main drivers of world economies and the source of policymakers many blunders come from a combination of Koo’s piece on balance sheet recession and Eggertsson’s piece on Commodity Prices and the Mistake of 1937 (both discussed on this platform). The best line is bottom of page 3: “We find the effect of communication policy is highly nonlinear at zero interest rates.” No wonder Big Ben won’t entertain the prospect of higher rates even with recent favorable data. He’s finally learned his lesson. Lets just hope he doesn’t trade his grade on the last test only to fail miserably on the next one. Redemption might not come as easily.

All,
Great discussion as usual, but…
I’ve just now had a chance to catch up on the reading and must admit, I’m not the “Kevin” that posted that lovely reference to Richard Koo’s work and the present developments in our global political saga. Kudos to “the real Kevin”, I’d welcome you in class any day!
Thank you Dan and Yra for the kind remarks, I do indeed bring these discussions into the classroom, but needed to point out the misplaced kudos here!
Kevin Waspi